California is hard to beat. There are richer places with worse climatic conditions, there are (some) more pleasant climates with less efficient economies, but it is really hard to find a place on the planet where it is more pleasant to live. and to work. There is a consensus among smart people that the Bay Area is the place to go, and they move accordingly.
Smart people are usually right on average. But when smart people hear to say that you can make a decision without thinking too much, beware: the reverse of intelligence is the ability to rationalize bad decisions instead of admitting your errors. It took a lot of intellectual power to streamline Superbowl ads and free cat litter delivery in 2000; It took a similar amount of intelligence to think that subprime mortgages could be grouped into securities as safe as treasuries.
There are three related problems that make California economically fragile, and a fourth that worsens the situation:
- This is not the best place in the world to start a startup.
- Gains from the existing technology industry are increasingly going to (a) passive investors and (b) lucky owners.
- The state government is a leverage bet on technology compensation.
- These three problems, which are interrelated, will not present any visible symptoms until they are definitively repairable.
Here in New York, we attach great importance to elegant design and high production values.
The good news, as it is: part of my bear case on the Bear Republic is that its most valuable assets can simply be recovered, which is not a bad place at the moment . If you have a good offer from a big tech company, go to Mountain View, Los Gatos or even San Francisco. (If you can afford the rents and carpools of Pacific Heights everywhere, you can pretend you do not live in San Francisco at all.)
But if you're thinking of starting a business, take a look at Austin, Brooklyn, Denver or Seattle. All of these places have the same problems as California, but on a smaller scale.
The Californian cycle
Since the late 1970s, California has benefited from a virtuous cycle that unfolds as follows:
- A group of smart people decides to solve a complex technical and commercial problem.
- They raise money, start a business and distribute stock options to former employees.
- The company grows and sells or becomes public.
- The founders retire, get bored after a few days and come back to step two, except that they write the checks.
Each generation of technology has been disproportionately funded by the founders of the previous generation. Kleiner Perkins' Kleiner and Perkins were the first employees of Fairchild and Hewlett-Packard. Fairchild and Intel spawned Mike Markkula, who retired at age 32 and then withdrew after meeting Jobs and Wozniak. Sun Microsystems spawned Khosla Ventures and Andy Bechtolsheim, a providential investor so aggressive that he has already written a check to a company that did not exist yet. (It worked.)
For this cycle to work, your ecosystem needs three things: large companies that can buy small businesses and generate cash flow; rich people who always want to get rich but do not want to be CEOs anymore; and new businesses that can survive long enough to raise money to join the other two categories. The cycle also benefits from the Alchian-Allen effect: the agglomerated industries have higher productivity, which increases the cost of living and eliminates the cost of living of other industries, thus increasing the concentration over time.
New small businesses are the most fragile and least visible part of this ecosystem. They are hard to see because the best companies keep a low profile (a CEO with the time to cultivate an image is not a busy CEO writing code or talking to customers), and because reporters are always willing to talk about a company fulfilling its role. from Hot New Startup. When Genentech is a startup, they will write on Genentech; When there is no news Genentech, they will write more about Theranos.
New businesses are essential because whenever a new technology or a new way of organizing a business is organized, it is unclear whether the result will be a larger or smaller industry. At the first appearance of Uber, you might wonder if it would be 10 times more important than the car rental market or if the return on investment should be brought below the cost of capital by creating an unlimited offer of drivers. (You can still have this debate, but it's harder to deny the opportunity.)
Since startups increase the gaps in the industry in which they are created, their natural group is a person who has no capital deployed in the industry. If you own an asset, you want low volatility. As a start-up is an option to buy on any business, it enjoys increased volatility.
Historically, startups have created a constant supply of volatility for technology companies. the next generation is still cannibalizing the previous one. The chip companies of the 1970s therefore created the PC companies of the 80s, but these companies bought chips less and less expensive, trivializing the product until Intel manages to defend itself. Meanwhile, the operating system has turned PCs into commodities, then search engines and social media have transformed BONE in a commodity, and presumably this process will continue indefinitely.
From the point of view of the financial markets, technology companies are going through a golden age when they are developing rapidly and trading at record rates, and suddenly they are trading at lower rates than the market because their turnover is growing flat at best and unstable at worst. What is worrying is that if we have fewer startups, this valuation compression will start to happen later, if at all. If you're just looking at the public markets, all you'll see is that the numbers have never been so good, and if you look at the private markets, you'll see that the bubble that worries you has become less foamy.
Rate of land and burns
The main reason why startups are finding it increasingly difficult to start in California is that the incremental cost of creation and growth has increased. Two monopolies are to blame: the owners and platform companies.
The owners are the most boring. A California landlord is generally not much more qualified and talented than other landlords; they had just owned property in a place with a high concentration of engineers (thanks to good schools) and hippies (thanks to the liberal art programs of these schools, as well as the fact that you could sleep at home). outside year-round at SF). Engineers make sure to meet the growing demand for real estate; the hippies conspire with the owners to limit the supply. The funniest case study is perhaps the one that took four months in San Francisco to determine that a laundromat was not a historic site that the city could not afford to demolish.
I lived in the Midwest, on the border between Texas and Mexico, and in New York, and when I moved to San Francisco, I was surprised to see that anti-immigrant sentiment was all there. made socially acceptable. Literally, as I was going to work, I saw propaganda posters on the fact that people like me who moved to San Francisco had an interest in packing and leaving – or else. I can understand some of the discomfort with the changes in our community brought about by immigration, whether they are smart people from foreign countries or just people from other cities. But the policies chosen by SF are simply pathological: the city reduces the supply of housing to discourage gentrifiers to settle, that is to say that the gentrifieurs oppose the natives. The rising cost of living is driving an increase in the number of industries, reinforcing the dominance of technology companies, and the increasing share of their residents in technology, which means that advanced technology is increasingly becoming fixed the price of the housing market. If San Francisco wants to eliminate gentrification, they will have to accept becoming very poor. If they want to mitigate the impact of gentrification, they should start building high-density Stuy Town style apartment buildings.
Restrictions on the real estate supply have a perverse effect. According to the law of supply and demand, they mean that the demand is immediately and indefinitely reflected in the price. As the demand is determined by the incomes of people who are thinking of earning this sum for next year, the characteristics of the cash flow of a city's businesses determine the effect of high real estate prices. In New York, finance and law start paying you immediately. It is rare for a start-up financial business to generate negative cash flow for homeowners after the first year. Other industries in New York have worse immediate cash flow prospects – media, fashion and music, for example.
For a city to have a flourishing arts scene, you must combine:
- Families or nightlife, both of which produce a demand for reasonably educated workers in non-traditional or flexible jobs as babysitters or bartenders.
- Cheap neighborhoods that are not dangerous. My current neighborhood, Williamsburg, was that role ten years ago.
- On the rise, either in the form of selling or marrying someone with a boring but lucrative job.
New York manages to combine all these elements in an intelligent way. For example, the New York restaurant sector benefits from two shifts because finance and media / mode are essentially in two different time zones. Merchants leave work at 5 am and hold dinners at the expense account at 5:30 pm; At a time when the table is clear at 8 am, it is time for the advertising agency and fashion professionals to introduce themselves. their expense account dinner. New York's nightlife is fueling the family's constitution, maintaining a balance between the demand for babysitters and bartenders, while maintaining wages by increasing supply. And in a broader sense, the status in New York is a progressive tax on wealth because the city is full of opportunities conspicuous consumption. You can earn below the poverty line and save money, at least if you are healthy and not disabled; but as Tom Wolfe pointed out in the '80s, you can also afford to earn a million dollars a year.
Start-ups are not like the low-paying jobs in New York; There is a "marriage market" in that an exit opportunity is to meet with a Corp Dev Mapper and decide where you want to settle. But that takes a while and, unlike New York, the economically disadvantaged part is the one who pays for the dates, at least in terms of opportunity cost.
There is anecdotal evidence on this subject. When Airbnb was just starting, the founders spent years going bankrupt. It is hard to imagine that a person living in the Bay Area spends a lot of time today going bankrupt. they spent too much on rent and had to go home or find a job at BigCo. Y Combinator has implicitly recognized it. When the program started in 2005, they offered the founders up to $ 20,000 to spend the summer running a startup. Now it's $ 120,000. This is a compound growth rate of 14% of the minimum amount of cash needed to start a business. YC has also grown, but it's hard to count on an organization to curb the pace here. As long as the higher rents increase the cost of creating a pre-revenue company, fewer people will join it, so more people will join established companies, earn market wages and continue to work. increase rents.
One of the things they will do here is to optimize the ad load, which imposes an extra tax on startups. More dangerously, it is an additional tax on growth rather than a fixed tax on the workforce; it therefore puts pressure on the year's valuations, not just on the initial cash flows. According to Social Capital's 2018 letter, nearly 40% of venture capital funds are devoted to advertising on the largest research channels, social networks and e-commerce. These channels have adapted to a world where they are the best place to adapt because they have the widest audience, which means they have more money to optimize the capture of their income. Thus, the ads are better targeted, their load increases over time, more content is transferred into the walled garden and it is increasingly difficult not to pay an economically effective ad price (read: very high).
Digital homeowners at least homesteaded their land and have been worth it to rent. Unfortunately, they are much better able to apply Laffer's optimal tax rate on the profits of their tenants.
Public pension funds: a slow motion on the bank
You may notice that my thesis is about "California," but my comments have been limited to the San Francisco Bay Area. The reason is that the Bay has provided California with huge capital gains and capital gains tax gains in recent decades, expenditures that the state has typically spent as fast as possible. Public spending tends to be difficult, especially because one of the easiest ways to give money is to get more cash flow today in return for higher support.
The last piece of the California puzzle – after the property tax on low-cash start-ups and the platform tax on startups in a growth phase – is the literal tax that weighs on everyone.
There are two key points to understand about California's financial situation:
- Income taxes, which are volatile, are an important part of government revenue. And taxes on capital gains are in the highest numbers. Since capital gains are an integral part of income over time (this is a change in the market estimate of the net present value of all future revenues of a business), they are therefore particularly cyclical.
- Californian public pensions are massively underfunded (the $ 769 billion in this article is overestimated, but it's a good direction).
Now, consider the incentives offered to a person living in California during a recession. Budgets are reduced, but government staff and allowances are difficult to manage because of strong unionization. The net result is therefore a reduction in the new services offered. At best, this means that the state government is stuck to solve the most pressing problems as its budget increases; at worst, it means that the state is only an employment program. Although there is pressure to lay off workers, they are putting more pressure on them not to do so – the stability of a job in the public service is particularly desirable when the unemployment rate is high.
So, something must give: taxes must increase. As taxes increase, people begin to consider living elsewhere. (We already see this in people who run mature businesses, they like to retire in Florida or a year and a half before closing a sale, so they avoid the capital gains tax.) Whenever the base plate decreases, the tax burden of the people who stay behind rise.
The big companies will not leave right away. The network effects of the array are too strong. They can expand other offices and employees will change, but the Stanford / Berkeley / Caltech pipeline to Big Tech Company will persist. However, the current crop of large companies will remain the big technology companies in 2030 and 2040.
In the long run, California's future resembles New York's, with the exception of New York City, but with a better weather. There will be large companies that will slowly decline, the tax base will run out and politicians will have to find ways to raise the taxes of the remaining citizens while forcing them to tolerate levels of services identical or reduced government. Ultimately, this will reduce the price of housing, but not in a way to revitalize startups. Instead, we will have a dynamic in which a house that was 50% too expensive a million dollars would still be $ 750,000.
Once upon a time, California was cheap. In the 50s and 60s, it was a place where you could work part time to fund your biker gang. In the 1970s, you could work part-time to finance your revolutionary terrorist cell. Such ancillary projects are unachievable today. If you are thinking of launching a massive bombing campaign in a San Francisco home, you must gather at least one six-digit seed.
You can see the decline over time:
As the talent market becomes more efficient and the supply of housing remains limited, the burn rate required for startups will increase, making them more and more expensive. See you in the history of Airbnb, but with higher rents and it's the story of three guys who run a novelty website for a while before landing all the jobs in designing microsites marketing for Oracle.
California politicians will always be able to say, "We are so happy to be home to companies like X, Y, and Z." It will take them a long time to realize that "X, Y, and Z Have changed every five years, so it was every ten years, it was the same business for a generation. By the time they realize that big new businesses are not being created nearby, the first cluster of startups will have already had its first set of releases, and Austin or Portland or Raleigh will be full of angel investors and small, angry venture capital stores. to perpetuate the local boot cycle.
Californians will end up as land nobility in England from the interwar period. Beautiful homes, an illustrious history and no way imaginable to pay their bills.
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